Investors Cheer, U.S. Jeers at Tax-Driven Deals: Real M&A

Workers assemble Medtronic Inc.'s Capsure Sense Leads along a production line at Medtronic Singapore Operations (MSO), in Singapore. Medtronic is the latest and largest company to say it will renounce its American address as part of its planned $42.9 billion takeover of Dublin-based Covidien Plc. Photographer: Munshi Ahmed/Bloomberg

June 17 (Bloomberg) -- Uncle Sam may not be a fan of cross-border takeovers that allow U.S. acquirers to avoid high
corporate tax rates. Investors, however, are cheering.

Since 2010, stocks of American companies that announced or
completed purchases of an overseas target to shift their
incorporation abroad and avoid onerous U.S. levies typically
outpaced the MSCI World Index, according to data compiled by
Bloomberg. They beat the gauge by 15 percentage points, based on
the median performance of 14 U.S. acquirers.

Medtronic Inc., a Minneapolis-based medical-device maker,
is the latest and largest company to say it will renounce its
American address as part of its planned $42.9 billion takeover
of Dublin-based Covidien Plc. While shares of $60 billion
Medtronic declined yesterday after the deal was announced, the
tax-inversion strategy may free up almost $14 billion in cash
the company now holds outside of the U.S., allowing it better
use of those funds.

“They’re just doing what profit-seeking people would do --
arbitrage the tax differences in these geographies,” Todd
Lowenstein, a Los Angeles-based fund manager at HighMark Capital
Management Inc., which oversees about $16 billion, said in a
phone interview. “They’re getting rewarded because it makes
sense and the market recognizes that.”

Inversion deals are on the rise as the largest U.S.
companies, facing a corporate tax rate that’s more than double
places such as Ireland, seek lower tax rates and ways to spend a
stockpile of almost $2 trillion in overseas cash. Medtronic
follows some 44 American companies that have reincorporated
abroad or plan to do so.

Injecting Value

Of 14 companies that announced or completed deals to shift
their domicile since 2010, eight have outperformed the MSCI
World Index, according to data compiled by Bloomberg. All but
three have gained since announcing their transactions.

“You’re injecting value with the tax benefits,” Martin
Sullivan, chief economist at Tax Analysts in Falls Church,
Virginia, said in a phone interview. “That gets reflected in
the share price.”

Neither Medtronic Chief Executive Officer Omar Ishrak nor
the company’s executive team have to move to Ireland to
consummate the purchase of Covidien. While the company’s tax
rate isn’t expected to change much, Ishrak said the transaction
will let Medtronic better use profit earned overseas, which it
plans to reinvest in the industry.

Big Wallet

Companies including Valeant Pharmaceuticals International
Inc. and Actavis Plc have taken advantage of lower tax bills to
pursue additional takeovers.

“That tax matters,” said Lowenstein. Redomiciling in a
lower rate country means “you have a bigger wallet to do
things.”

Valeant has performed the best among tax-inversion
companies, gaining 707 percent since it announced plans to buy
Biovail Corp. in June 2010.

Tower Group International Ltd. has had the worst
performance, declining 89 percent since it said it would buy
Canopius Holdings Bermuda Ltd. in July 2012. While the merger
allowed Tower to redomicile in Bermuda, which doesn’t have a
corporate income tax, Tower has faced reserve shortfalls. Tower
agreed in January to sell itself.

Shares of Medtronic fell 1.1 percent to $60.03 yesterday
after earlier rising as much as 5.3 percent. The size of the
transaction and questions on how accretive the deal will be may
be giving investors pause, according to Joanne Wuensch of Bank
of Montreal. Standard & Poor’s also said it may cut Medtronic’s
credit rating because of the deal.

‘Bold Transaction’

Still, the Covidien purchase “makes a lot of sense over
time,” Wuensch, a New York-based analyst, said by phone. “It’s
a bold transaction. The risks of the integration balance the
benefit of positioning this company over time in a changing
health-care environment.”

Medtronic stock climbed 2.6 percent to $61.58 today.

Corporate inversions that occurred between 1993 and 2013
outperformed the market average in the years following the
transactions, according to a report by Elizabeth Chorvat at the
University of Chicago. Even so, companies’ stock prices don’t
always respond positively to the announcement of an inversion
deal, Chorvat wrote.

Medtronic can walk away from the deal if U.S. tax law
changes, the company said in a regulatory filing. The tax clause
would also come into play if both houses of Congress pass
legislation that would treat the combined company as an American
corporation for federal tax purposes, even if it’s not
immediately signed by the president.

Congressional Ire

The medical device maker is joining the rise in inversion
deals as government criticism of the transactions is mounting.
After Pfizer Inc. attempted to shift its domicile to the U.K.
with an acquisition of AstraZeneca Plc, U.S. Senator Carl Levin,
a Michigan Democrat, proposed a bill last month that would make
it harder for companies to shift their addresses overseas to
avoid taxes.

In an attempt to discourage more companies from inverting
before Congress acts, the bill would be retroactive to May 2014.
A congressional panel last month estimated that future deals
will cost the U.S. $19.5 billion in tax revenue over the next 10
years.

More Options

For now, that’s probably not going to dissuade companies
from seeking to re-domicile, said Sullivan of Tax Analysts. In
fact, it may spark a surge in deals, he said.